Question 2 (a)
Cash flows and NPV of installing the machine
15 marks
- Time to write
- About 30 minutes
Question
Question 2 (a) · 15 marksSunrise Ventures is considering installing a machine that costs ₹2,40,000, plus installation charges of ₹48,000. The machine has a life of 5 years, and its expected scrap value is ₹24,000 at the end of it.
For the first two years, the machine is expected to produce 2,400 units annually. In years three to five, production is expected to rise to 3,600 units per year. The product's selling price is expected to be ₹30 per unit in the first three years and ₹36 per unit in the last two years.
Operating costs are estimated at ₹12,000 per year for the first three years and ₹19,200 per year for the last two years. The company uses straight-line depreciation, and the tax rate applicable is 40%.
To determine whether the machine should be installed, we have to calculate the cash flows and evaluate the investment by the Net Present Value (NPV) method at a discount rate of 8%.
Reworded from the university paper: names and figures differ, the task is the same. The original paper belongs to the University of Delhi. See DU's question bank.
Before you write
Read off the question and its marks
Read from the question
- evaluateBoth sides: the strengths, the limits, then your own view.
- Net Present ValueCash flows year by year in one table, then discount, then a one-line decision.
Write it in this order
- Read the data; note exactly what is asked 2 min
- 1 Cost, depreciation and scrap 2 marks 4 min
- 2 Sales and operating costs year by year 3 marks 6 min
- 3 Tax and cash flows after tax 5 marks 9 min
- 4 Present values and NPV 3 marks 6 min
- 5 Decision 2 marks 1 min
- Check: arithmetic, units (₹, %), final answer underlined 2 min
Short on time? End with step 5's one-line decision, whatever happens: never leave the figures without it.
Try it first. About 30 minutes for 15 marks. Write it out, then open the solution.
Solution
Hover or tap a marked figure, like 72,000, to see how it is made and where else it appears.
Cost and depreciation. Cost = 2,40,000 + installation 48,000 = ₹2,88,000. Straight-line depreciation = (2,88,000 − 24,000) ÷ 5 = ₹52,800 a year. The scrap value of ₹24,000 is a cash inflow in year 5.
Cash flows after tax and present values (PV factors at 8% from the table)
| Year | Units | Price (₹) | Sales | Operating costs | Profit before depreciation | Depreciation | Profit before tax | Tax @ 40% | Profit after tax | CFAT | Scrap | Net cash flow | PV factor @ 8% | Present value |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 1 | 2,400 | 30 | 72,000 | 12,000 | 60,000 | 52,800 | 7,200 | 2,880 | 4,320 | 57,120 | — | 57,120 | 0.926 | 52,893.12 |
| 2 | 2,400 | 30 | 72,000 | 12,000 | 60,000 | 52,800 | 7,200 | 2,880 | 4,320 | 57,120 | — | 57,120 | 0.857 | 48,951.84 |
| 3 | 3,600 | 30 | 1,08,000 | 12,000 | 96,000 | 52,800 | 43,200 | 17,280 | 25,920 | 78,720 | — | 78,720 | 0.794 | 62,503.68 |
| 4 | 3,600 | 36 | 1,29,600 | 19,200 | 1,10,400 | 52,800 | 57,600 | 23,040 | 34,560 | 87,360 | — | 87,360 | 0.735 | 64,209.60 |
| 5 | 3,600 | 36 | 1,29,600 | 19,200 | 1,10,400 | 52,800 | 57,600 | 23,040 | 34,560 | 87,360 | 24,000 | 1,11,360 | 0.681 | 75,836.16 |
| Total PV | 3,04,394.40 |
| ₹ | |
|---|---|
| Present value of cash inflows | 3,04,394.40 |
| Less: cost of the machine | 2,88,000.00 |
| NPV | 16,394.40 |
Decision. The NPV at 8% is positive, so the machine should be installed: it earns more than the 8% required and adds ₹16,394.40 to the firm's value.
Where the 15 marks sit
| # | Component | Marks |
|---|---|---|
| 1 | Cost, depreciation and scrap | 2 |
| 2 | Sales and operating costs year by year | 3 |
| 3 | Tax and cash flows after tax | 5 |
| 4 | Present values and NPV | 3 |
| 5 | Decision | 2 |
| Total | 15 |
Report a problemopens an email to admin@getkunji.com with the question ID7357-Q2aalready filled in.